Sebi may review rule for funds targeting overheated small caps

India’s markets regulator Monday said it is open to revising rules for mutual funds investing in small-cap stocks amid rising concerns about stretched valuations for this segment.

The Securities and Exchange Board of India will review its rule that mandates small- and mid-cap funds to invest at least 65% of their assets in such stocks if fund managers find it is “restraining risk management,” Chairwoman Madhabi Puri Buch told reporters in Mumbai.

Her comments come amid Indian regulators’ growing concerns over some parts of the economy and markets showing signs of overheating due to a boom in the nation’s equities. 

Last month, Sebi asked money managers to take steps to protect investors from the froth building up in small- and mid-cap stocks following large inflows into funds investing in these segments.

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Shares of small- and medium-sized companies have powered the record rally in Indian shares in the past year, with funds focused on these stocks getting nearly 40% of net equity inflows of $19.5 billion in 2023. 

A gauge of small-cap stocks dropped as much as 1.7% on Monday, the biggest intraday slide since March 6. The measure trades at more than 22 times one-year forward earnings, higher than the 10-year average. It surged almost 50% in 2023.